‘Recession? OK, When?’ A Skeptic Entertains The Doomsayers

Two weeks ago, one equities strategist asked if US downturn worries were “more fear than fact.”

It was a fair question then and it’s still a fair question, even as Q1’s “surprise” contraction pushed the world’s largest economy to the brink of a technical recession.

Q1’s GDP headline was impacted by trade and inventories, prompting some to call it a false optic. I tend to think that even if you’re inclined to look past the numbers, the outlook is increasingly bleak considering deeply negative real wage growth, persistently elevated inflation, palpable consumer angst and a Fed bent on the most aggressive tightening cycle in decades.

Read more: US Economy Moves To Brink Of Recession

That said, recession predictions are almost consensus, certainly in the market’s collective consciousness, if not yet in official house calls on Wall Street.

Recession banter tends to feed on itself give that prophesying calamity confers upon would-be sages an air of deep insight. In short: Bulls who are right seven times out of 10 are derided mercilessly when they’re wrong, but bears who are right once per decade are celebrated for uncanny prescience. So, once the doomsaying starts, and the media lavishes coverage on early adopters, the allure of the limelight tends to attract new entrants to the fear market.

Setting aside the possibility that recession banter may be, in part anyway, a function of a self-feeding media cycle, it’s worth noting that March’s personal income and spending data for the US was fairly robust. At the least, it offered a glimmer of hope.

Circling quickly back to where we began, Wells Fargo’s Chris Harvey, who earlier this month said recession fears might be overblown, revisited the issue in a new note.

“Let’s assume we are wrong and recession is heading down the pike,” he said, in a section called “Recession? OK, When?” In such a scenario, the most important question is one of timing. After all, he wrote, being too early is the same as being wrong, and being too late in this context is to be “wronger” (his word).

Unfortunately (if you do suspect a recession is coming and you’re not excited about it), recent equity declines and de-rating suggest the downturn “would need to arrive soon,” Harvey said, before taking a brief trip down memory lane. To wit:

• 2000-02: The 2001 recession’s “official” start was in 1Q01; the market priced in a recession only four months earlier. The S&P 500 was -12.7% in Aug-Dec 2000; in the prior eight months, the market was +4.1% (and trending higher).
• 2007-08: The “2008 recession” started at the end of 2007. The SPX was -3% in 4Q07. The market arguably had it right in the summer of 2007 with the Quant meltdown, so we could stretch the window to 4-5 months ahead of time. Credit markets froze in the summer of 2007, equity factor performance went haywire, and the Fed had to provide additional accommodation or liquidity to a difficult situation.

If (recent) past is precedent, the recession that at least one bank is now openly predicting should start in Q3.

Harvey suggested that isn’t a “reasonable” projection. As alluded to above, he cited the impact of trade and inventories on Q1’s negative GDP print (figure below), said consumer-related categories remain emblematic of “a healthy economy” and called earnings “consistent” with that interpretation.

For Harvey, the selloff in US equities is about growth, but not economic growth. Rather, growth stocks, which are under immense pressure, even at the mega-cap level.

Amazon’s Friday plunge was the second-largest single-session value destruction event in US market history, for example, behind only Facebook’s February debacle. Netflix’s post-earnings plunge was the eighth-biggest one-day market cap implosion on record.

Whatever the case, Fed fears and concerns about the resilience of the economy are an aggravating factor. “To the casual observer, the Fed’s comments and the growing fear of a Fed-driven recession sank the market,” Harvey wrote, calling that “a neat-and-simple explanation,” but one he believes is “misguided.”

For BofA’s Michael Hartnett, things are more clear-cut (they always are). The Fed, he sighed this week, is going to hike until something snaps.

The figure (above) is an annotated history of the Dow versus Fed funds.

“[We] still think a 1973/74 analog is worthy,” Hartnett wrote. “Inflation means the Fed must tighten until it breaks the economy or the market.”

Until that happens, he warned, “asset prices must reset lower.”